Quick overview

Refinancing can either reduce your rate or term (rate-and-term) or let you tap home equity for cash (cash-out). Both replace your current mortgage with a new loan, but they serve different goals: cost reduction and improved loan structure versus accessing liquidity for spending or debt consolidation.

Decision framework: when to prefer a rate-and-term refinance

  • Primary goal is lower monthly payment or lower total interest: pick rate-and-term when market rates are meaningfully below your current rate and closing costs are justified by savings.
  • You want a shorter term to pay less interest overall: move from a 30-year to a 15- or 20-year loan if you can afford the higher monthly payment.
  • You’re not tapping equity and want to minimize borrowing cost: rate-and-term keeps your loan balance similar and often carries lower fees than cash-out.
  • You plan to stay in the home long enough to reach the break-even point on closing costs (use the break-even formula below).

When a cash-out refinance is the better choice

  • Need for lump-sum funding backed by your home: home improvements, consolidating high-interest debt, or a business investment.
  • You have substantial equity and want a single loan: cash-out replaces the first mortgage and supplies cash rather than adding a second lien.
  • You accept a larger balance for the cash benefit and potential tax or return on investment (for example, renovations that raise home value).

Quick checks before you decide

  • Break-even: divide total refinance costs by monthly savings to find months to recoup costs. If you plan to move before that, refinancing may not pay off.
  • Loan-to-value (LTV): cash-out options depend on available equity; many conventional lenders limit cash-out LTV (consult your lender and CFPB guidance). See CFPB on home equity and refinancing: https://www.consumerfinance.gov.
  • Credit score and DTI: both affect pricing; cash-out raises the loan amount and can change your debt-to-income ratio.

Practical example

  • Rate-and-term: you owe $220,000 at 4.75% on a 30-year loan. If you can refinance to 3.75% and closing costs are $4,500, calculate monthly savings and divide costs by savings to find the break-even period.
  • Cash-out: home value $350,000, balance $200,000. A cash-out to $270,000 creates $70,000 cash after costs; compare the new monthly payment and long-term interest to alternatives like a HELOC. For HELOC vs cash-out details, see our guide: HELOC vs Cash-Out Refinance for Renovations.

Costs, taxes and risks

  • Closing costs: cash-out refis typically cost more because the loan amount is larger and underwriting can be stricter; read tips on minimizing fees here: Strategies for Negotiating Refinance Closing Costs.
  • Taxes: mortgage interest may be deductible only when funds are used to buy, build, or substantially improve the home. If you use cash-out proceeds for other purposes, the interest may not be deductible — check IRS rules or consult a tax advisor (see IRS guidance at https://www.irs.gov).
  • Replacing a low-rate loan with a higher balance can increase total interest paid — factor long-term cost, not just monthly payment.

Alternatives to consider

Pro tips from practice

  • Always run a break-even analysis and compare APRs, not just the rate.
  • If using cash-out to pay off consumer debt, ensure the new mortgage rate and term actually reduce total interest versus the debt you’re eliminating.
  • Ask lenders for a Good Faith Estimate and challenge fees you don’t recognize.

Common mistakes

  • Ignoring the break-even period and moving too soon.
  • Tapping equity for consumption without a plan to repay — this converts home equity into unsecured spending and increases housing risk.
  • Overlooking tax implications of how you spend cash-out proceeds.

Bottom line

Choose a rate-and-term refinance when your objective is lower interest costs, smaller monthly payments, or a shorter term without raising your loan balance. Choose a cash-out refinance when you need a large, single lump sum and are comfortable increasing your mortgage balance for that liquidity. Run the numbers, confirm eligibility and LTV limits with lenders, and consult a tax professional for deductibility questions (CFPB; IRS).

Sources & further reading

Professional disclaimer: This page is educational only and not personalized financial or tax advice. Consult a licensed mortgage professional and a tax advisor before refinancing.